Is VXUS A Good Long-Term Buy For ETF Investors? (NASDAQ:VXUS)

The Vanguard Total International Stock ETF (NASDAQ:VXUS) is meant to track the universe of foreign equities with exposure across mega-cap leaders down to the micro-cap companies. The name of game here is diversification to capture the high-level themes in international stocks as an important market segment while eliminating company-specific risk.

Even as market conditions have been volatile at the start of 2022, there are plenty of reasons to maintain a positive outlook with international stocks well-positioned to move higher going forward. VXUS with an expense ratio of just 0.07% is a good choice as a core holding for investors to move beyond U.S.-centric portfolios and ultimately improve risk-adjusted returns over the long run.

What Is The VXUS ETF?

The VXUS ETF with over $50 billion in net assets takes a full replication approach on the underlying “FTSE Global All Capitalization ex-US Index”. As the name implies, the strategy considers all non-U.S. stocks with broad exposure to developed and emerging markets. The current portfolio of 7,873 stocks in companies located in over 46 countries highlights the fund’s extensive reach.

Through a float-adjusted market cap weighting methodology, the largest companies retain their relative importance, while the smaller holdings also play a role in balancing the risks and return potential. Taking a look at the fund allocation by country, the weightings here reflect the relative size of each region’s publicly traded equity market. By this measure, Japan with a 15% weighting is the most well-represented country, followed by the United Kingdom at 10%, while Canada and China both represent 8% of the fund.

Approximately 75% of the holdings are classified as from “developed markets” while 25% are in emerging countries. There is an understanding that developed markets which include Japan and most of Europe have lower structural risks related to the political and business operating environment. On the other hand, the attraction of emerging markets is the higher growth potential.

By sector, financials are the largest group at 19% of the holdings. This considers that for many countries, domestic banks are often the most important publicly traded companies, uniquely positioned to represent the trends of the local economy. This is in contrast to basic material and energy sector stocks that together represent about 14% of the fund that are typically valued based on trends in global commodity prices. Overall, the exposure of VXUS has a good balance between sectors.

A key point here is that given the size of the portfolio with diversification taken to an extreme level, the vast majority of the stocks only have a fractional position in the fund. The top holding is Taiwan Semiconductor Manufacturing Co. Ltd. (TSM) given its $500 billion market value, but only represents 1.6% of VXUS.

The top 10 holdings overall have a combined 9% weighting in the fund which is in contrast to the Vanguard S&P 500 ETF (VOO), which tracks the largest U.S. companies and the top 10 stocks total 30%, for example. The point here is to say that the underlying performance of a single holding won’t necessarily move the needle for the fund while the macro trends are going to be more important. Down the list of top holdings, the stocks here are recognized as market leaders and typically operate globally.

VXUS Performance History

With a fund inception date of January 2011, VXUS has faced a rocky road over the past decade. The fund has returned a cumulative 64% over the period representing an average annual return of around 5% per year. This is a significant underperformance compared to the S&P 500 which has delivered nearly three times the return, gaining a much stronger 325% in the same timeframe. Before drawing any conclusion, a couple of factors explain VXUS’s lagging return.

Looking back, the timing of the fund’s launch coincided near the top of the last “commodity cycle” as metals and energy prices moved sharply lower through around 2015. Emerging markets within VXUS were particularly hit by weaker economic growth during the period.

At the same time, the U.S. economy was overall very resilient through the 2010s which was defined by a historic bull market in stocks particularly led by innovative high-tech leaders that are not included in XVUS. Part of this dynamic contributed to the strength of the U.S. Dollar which has gained over 25% in the last decade against a basket of foreign currencies.

This is important because the FX risk with VXUS holdings generating sales and earnings in currencies beyond the U.S. dollar remains a risk for the fund. The takeaway here is not a criticism of VXUS but more about the perspective on how international stocks as a market segment have continued to be volatile.

Clearly, if we had a crystal ball showing a certain fund outperforming or “XYZ” delivering so-and-so return, then there would not be a need for VXUS or any ETF. We make the case that the attraction of VXUS now is the inherent uncertainty in stocks that make diversification so critical.

The fund’s return looks more encouraging over the past 2 years, returning 41% compared to 60% in the S&P 500. It’s possible VXUS and international stocks as a group can outperform even the S&P 500 over any particular time frame going forward.

Finally, we highlight that the performance of VXUS, up 18.5% over the past year, is in-line with some other comparable “international stocks” ETFs. As a benchmark, we include the iShares Core MSCI Total International Stock ETF (IXUS) and the Vanguard FTSE All-World ex-US ETF (VEU), both with a marginally lower return over the period closer to 18%.

The reality is that all three of these funds are very similar in terms of strategy and market exposure, technically tracking different indexes with subtle differences in methodology. That said, VXUS stands out with its larger portfolio of +7,800 holdings compared to “only” 4,325 in IXUS and 3,640 in VEU. With a focus on diversification and the most comprehensive exposure, VXUS is our top pick in this class. All three funds also offer a similar dividend yield of around 3.3% through a quarterly distribution schedule.

Is VXUS A Good Long-Term Investment?

Despite the performance of international stocks as a group over the past decade that leaves a lot to be desired, there is nothing inherently wrong with the market segment. It’s easy to get caught up in the day-to-day headlines and short-term market gyrations. The key here is to look at VXUS as a long-term investment and take confidence that the outlook over the next several years is positive.

In our view, the structural tailwinds that support a positive outlook for the global economy including factors like steady population growth and increasing demand for more goods and services remain in place and can accelerate over the next decade. For emerging markets, in particular, expanding access to the internet and mobile devices from a rising middle class of consumers are long-term investing themes that remain in place. The underlying companies within VXUS will benefit as they consolidate their market share and innovate through the use of new technologies adding efficiencies in all sectors.

For the rest of 2022, we can argue that international stocks as a group have a better setup compared to U.S. companies given the current macro environment. Many of the countries represented within VXUS that are commodity exporters are seeing a windfall in trade from higher energy and even agricultural products as inflation winners. We expect these trends to continue.

This is despite the recent strength in the U.S. Dollar. While the Fed is taking a hawkish approach toward rates, keep in mind that several global Central Banks including the European Central Bank are also on track to start a tightening cycle. This opens the door for foreign currencies to reverse recent losses and even strengthen through 2023 adding an incremental boost to international stocks.

Putting it all together, the sentiment towards foreign stocks has been extremely poor but we see room for the pendulum to swing in the other direction. Stronger than expected economic growth over the next few quarters, possibly driven by the ongoing post-pandemic return to normal, can add momentum to financial markets.

Is VXUS A Buy, Sell, Or Hold?

We are bullish on international stocks through the VXUS ETF with a view that the recent weakness and ongoing market volatility represent an attractive buying opportunity. The fund’s current 3.3% dividend yield is at a level where the fund has tended to rally over the past decade as a measure of technical support with a few exceptions including the brief pandemic crash in early 2020. By this measure, we rate VXUS as a buy with the current level as an attractive entry point for a new investment or to add to an existing position.

In terms of risks, we need to be cognizant that international stocks and broader financial markets remain exposed to global macro conditions. A deterioration in the growth outlook or some tail event such as an escalation in the ongoing Russia-Ukraine conflict would further pressure sentiment towards risk assets. FX risk is also a consideration in VXUS with the potential of a significantly stronger U.S. Dollar forcing a reassessment of the global growth outlook.

Overall, VXUS is a high-quality fund that performs exactly as intended for its particular exposure. We believe VXUS can work as an important component of a broader portfolio as a long-term core holding. The strategy we recommend is to complement a core holding in U.S. stocks with a smaller position in VXUS as a diversified approach to foreign companies. From there, investors that are more comfortable taking an active approach can look to tactically overweight certain sectors or equity factors depending on market conditions by supplementing VXUS with other more focused ETFs and or even individual stocks.